In the current economic environment there is quite a bit of hesitancy by most employers to increase their staff levels on a “permanent” basis due to the increased cost in taxes, benefits and risk of a future fire for the new hire. A tried and true alternative is to hire an additional resource on a temporary or contract basis. But when does that extra set of hands stop being an independent contractor and become an employee? The difference between an employee and a contractor is defined by the federal government, not on the employment terms you set out as an employer – so calling someone a “1099” doesn’t necessarily make it so. Someone is an independent contractor if, “…you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.” The “1099” reference reflects the tax filing completed by the contractor; for an employee you file a W-2 and for an independent contractor you file a 1099.

The “big deal” about defining an employee or contractor correctly is the risk of getting it wrong. A worker who is categorized incorrectly as an independent contractor may be eligible for back-pay, including eligibility to participate in benefits (medical, 401k, vacation, etc) from the original work date. There are also fines in the form of back taxes and additional fees, and compliance exists at a federal and state level.

Employers have a few options to address the 1099 dilemma:

1. Use overtime and reconfigure existing staff roles: depending on the required skill set and business it may be possible to invest in retraining and flex your existing talent to meet spikes in staffing need through a combination of overtime and reassignments. This is often an overlooked option, but reusing existing staff is often viewed positively by employees who see the cross training and extra pay as an investment, and can create a “we are all in this together” mindset across the business.

2. Employ everyone as a W-2 employee: costly option, and although you can control for some expense by bringing extra help in on a part time basis, you still have workers’ compensation, unemployment insurance and FICA costs.

3. Use an agency: a temporary agency is a good solution as the agency employs or contracts the worker and then “leases” them to you. The agency handles all employment, pay and administration, and charges a markup of from 25% to 100% of the wage rate received by the worker. There can be issues with quality and turnover as temps are usually working on a temporary basis until they can find full time employment, but this can be an efficient way to quickly fill sporadic talent needs.

4. Evaluate each potential hire: the IRS provides a test to determine if a worker meets the criteria for a 1099. The test boils down to three key criteria:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Unfortunately, employment is rarely this cut and dry, and your “best effort” isn’t a good enough defense in the event of an investigation or challenge.

Part of the right solution for you will be based on how you choose to run your business. Contractors can make a lot of sense for interim, short term projects; employee use becomes more important if the work and customer interface is something you want more control over, and an investment in training pays off with higher quality and productivity levels. Lastly, cost and complexity count too; short term contract labor is often cost neutral after you consider the markup against taxes, but there is a transactional cost to your business of constant turnover. Granted, needing extra resources in a down economy is a first class problem to have – but take care as you add that staff to avoid unnecessary costs and legal complications.